Restart: Six (Non-Cost-Cutting) Quick-Wins for US Automotive OEMs

Automotive OEMs faced challenges on multiple fronts, including an expensive shift to electric vehicle capital spending, new competitive threats from well-heeled technology companies, and structural declines in car ownership in favor of ridesharing. Then came COVID-19! In this article, we share six quick-win measures in pricing and sales that will help OEMs to not only survive, but also thrive as the industry emerges from an acute demand crisis.

When COVID-19 rapidly spread across the US, consumer spending, particularly on big ticket, durable goods such as cars, plummeted. In the automotive industry, production stops and already tight dealer inventory levels also contributed to a pronounced sales contraction, with analysts expecting 2020 sales to drop by 25-35% to somewhere between 12 and 14 million vehicles. While there are a few bright spots for OEMs, particularly those with exposure to adjacent categories such as recreational vehicles (RVs) and off road vehicles (ORVs), the auto industry is facing its biggest challenge since the 2008 financial crisis.

OEMs will emerge from the crisis transformed, for better or for worse. So what can they do to transform for the better, recover growth, protect margins, and enhance their competitive position? How can OEMs address this situation to come out stronger than before?

How OEMs can restart successfully

High fixed costs are extremely dangerous in times of crisis as volumes contract faster than costs and put pressure on both margins and liquidity. Therefore, the majority of players in the auto industry have been reducing and continue to reduce fixed costs, particularly within SG&A line items. This helps preserve liquidity and shore up company balance sheets in the short run. Measures that have an immediate effect on fixed costs without risking competitiveness when the economy picks up again are optimal. For example, delaying payments by extending payment terms is helpful. Laying off qualified people is questionable.

Cutting costs is a necessary but insufficient strategic move during a downturn. Companies should also focus on the other two variables of the profit formula:

Six quick-win pricing and sales measures for OEMs in an acute demand crisis

1. Optimize promotions

OEMs sell millions of cars but spend billions of dollars doing it. There is no question that incentive spend stimulates demand and stabilizes volumes, however, an efficient spend strategy is critical to maintaining both volumes in the short run and competitiveness in the long run. There is a tradeoff between addressing customers’ short-term pain points and destroying long-term value and brand equity. To navigate this tradeoff optimally, OEMs should invest in the right promotion levers while maintaining agility and optionality to pull spend levels back once demand recovers.

The key metric for OEMs to monitor is incentive spend per vehicle, which can be determined one of two ways: less absolute spend or amortizing spend across larger volumes. Commercial teams should focus on what they can control: spend levels and spend composition. OEMs should systematically analyze sources of incentive spend and prioritize those that are both low cost to the OEM and high value to the customer. In addition, resources should be concentrated on incentives that are flexible and can be dialed back once demand recovers. For example, in-kind cash discounts such as extended warranties or service contracts instead of outright cash discounts. There are three advantages with this approach:

• In-kind discounts generate volume while protecting MSRPs in the long run. After the crisis, it will be easier to dial-back in-kind discounts than outright price cuts
• The right in-kind discounts are often more efficient than cash discounts. They generate more volume for less investment, thereby increasing marketing efficiency
• The right in-kind discounts will generate volume now without burdening short-term cash flows (e.g. extended warranty)

2. Upgrade digital sales channels

A survey published in May by Cox Automotive found that two in three people are more likely to purchase a vehicle online than before the crisis. OEMs should ensure that both they and their dealer networks are digitally equipped to respond to these channel changes. The ability to replicate face-to-face or traditional field sales interactions as closely as possible using alternative communication tools such as video-conferencing and virtual showrooms is critical to maintaining profitable customer relationships in a physically distanced world. A case in point is General Motors recent promotion of its Shop-Click-Drive program, which allows consumers to receive quotes on vehicle trade in values, apply for vehicle financing, and even arrange for home delivery of new vehicles. In the words of CEO Mary Barra, “we’ll see more customers wanting to do most, if not all, of the transaction online.”

3. Upskill dealer sales teams

In our competitor audits, we often observe significant price leakage due to a lack of understanding and application of non-price variables in negotiations with customers. OEMs can upskill their dealer network negotiation capabilities in three areas: value articulation, objection handling, and selling techniques. In addition, creating quick-hit, virtual trainings to close near-term skills gaps in the sales force is an effective use of unused capacity due to lower dealer lot traffic. The upside of repurposing this time is substantial: effective integration and adoption of value-selling across a sales team can increase average vehicle selling prices by 5% or more within twelve months vis-à-vis enhanced up- and cross-selling capabilities.

4. Reduce psychological purchasing barriers

The current change in customer demand is driven by social distancing measures due to the health crisis AND by financial uncertainty due to the economic crisis. Short-term measures to alleviate both financial and psychological uncertainty will go a long way in keeping dealer inventory turns healthy and revenue flowing. Many car manufacturers are already putting guidelines in place, providing 0% APR financing for 84 months, delaying payments for 90 or 120 days, and arranging for contactless home deliveries of new vehicles. Hyundai’s Job Loss Protection Program offers up to six months of payment relief for those who lose their jobs due to COVID-19-related health issues after purchasing or leasing a new Hyundai vehicle between March 14 and April 30 2020. These bold moves are addressing the right pain points.

5. Adjust MSRPs to the next pricing threshold

Time and time again, research shows that customer willingness to pay is very inelastic in front of pricing thresholds, e.g. $1, $10, $100, $10,000, etc. Find out which thresholds are relevant for different market segments and adjust accordingly. Lower prices if they are just beyond a threshold. Increase them, if there is still room before reaching the next threshold. This measure alone can easily yield up to 0.5% ROS if implemented correctly – a substantial improvement in profitability for an industry with 10% operating margins.

6. Test new revenue models

Legacy automotive OEM revenue models focus on vehicle sales and aftermarket products and services. Both revenue pools are under pressure but for different reasons. New vehicle sales are down as US consumers forego big ticket purchases and increase savings rates in response to COVID-19. The automotive aftermarket has proven to be more resilient, however, as consumers hold onto their cars, average vehicle lives extend, and demand for spare parts naturally grows. The challenge for OEMs is that while they hold 80%+ market share in aftermarket service for vehicles less than two years old, it is less than 40% for vehicles two to six years old, and less than 20% for vehicles older than six years.

COVID-19 accelerated the need for OEMs to explore new revenue models and better monetize ancillary products and services. If properly designed and well executed, OEMs can reduce their dependence on the hard to predict, transactional cyclicality of new vehicle sales, e.g. through recurring revenue models around vehicles, options, services, as well as data. For example, ten-year service subscription offerings can increase aftermarket penetration, unlock recession-proof recurring revenue streams, make price levels seem a lot smaller, and relieve customer cash flow concerns. In addition, customers on a service subscription are happier customers. When they show up for service work they don’t fear a hefty charge. On the contrary, they enjoy the free coffee, smile, and have a relaxed look at new vehicle models. This increases customer loyalty AND shortens the vehicle replacement cycle.

Moreover, every modern car generates enormous amounts of data. This data can be monetized under different revenue models:

• Selling to third-party data providers (e.g. Kelly Blue Book, Nielsen, GfK)
• Selling to customers via enhanced product performance or service

One use case is providing information about the location and dimensions of potholes. OEMs can sell aggregated data to platform companies, municipalities, or repair companies, as well as use the data internally to create their own “pothole warning” features to improve the user experience and drive customer loyalty. If established OEMs do not develop recurring revenue models around vehicles, options, service, and data, new competitors will!

Originally published August 25, 2020 on the Simon-Kucher & Partners blog.

ABOUT THE AUTHOR

Justin Atwood is a Manager with Simon-Kucher & Partners in Boston. Justin specializes in growth strategy, commercial excellence and sales execution for industrial/capital goods and automotive companies across industry value chains, including manufacturers, distributors, dealers and retailers. His areas of expertise include pricing diagnostics, customer segmentation, go-to-market strategies, option pricing, value selling and negotiation skills.

Prior to joining Simon-Kucher, Justin worked with a leading investment management firm where he managed institutional portfolios with assets ranging from $50 million to over $5 billion. During his tenure at Simon-Kucher, Justin has led commercial transformations and value selling projects for CCC Information Services, EIS Inc., Genuine Cable Group, ClearMotion, Highline Aftermarket, Molded Fiber Glass Companies, and the CURT Group among other engagements.

Justin studied Economics and Philosophy at the Hamilton College and received his MBA as a Presidential Scholar from Babson College with high distinction (magna cum laude). Justin wrote his master’s thesis on forecasting US electric vehicle market development.